A Few Words on Executive Compensation

The topic of executive compensation receives a lot of attention in the financial media, and I think much of it is misguided. As an investor, I’ve looked at countless companies, and I can’t remember an instance where the level of executive pay has steered me away from the stock.

From my experience, investors are perfectly willing to put up with just about anything from a CEO as long as the stock is rising. Of course, that’s a big “as long as.”

There seems to be a built-in cynicism with many investors, and they’re predetermined to believe that the executives are looting the company at their expense. Human nature being what it is, yes, Enrons do exist. However, I prefer to focus on high-quality companies so the management has almost certainly proven themselves to be efficient by the time I look under the hood.

A few years ago, I was at the Wharton Economic Summit and one professor said that if we magically chopped the pay of every CEO by 25%, it would have almost no impact on market valuations. It’s simply not that big a portion of expenses.

I’m also afraid that many companies have reformed themselves backward. Since large cash payments don’t look good for senior managers, especially for a money-losing company, we’ve moved to a world of stock options. That had the added benefit of managers having, to borrow a tired phrase, “skin in the game.” But for me, as an investor, I hate the endless watering down of shares.

Plus, stock options aren’t the independent variables they’re made out to be. They’re great to use for companies with rising share prices. Hey, it’s free money! Here are some more grants! But when the shares start dropping, it’s not so much fun.

Executive compensation also distorts how much management really has at stake. I’m obviously a big fan of AFLAC and the company got tons of great press for their say-on-pay measure. Sure, that’s nice, but how important is it really? The Amos family has a fortune tied to shares of AFLAC. What Dan Amos takes in each year as CEO is probably pretty small compared to what he and his family have at stake. Mind you, I’m not criticizing him. I’m just saying let’s look at the big picture. He’s already rich and if next year’s pay is $3 million or $6 million, it won’t impact his life very much.

The problem is that any metric a board uses to base executive compensation will create problems. If they say that the CEO will get a bonus of, say, $5 million if ROE for the year hits, say, 18%, then the CEO will do whatever it takes to make the accounting work. The same for EPS or revenue growth – it doesn’t really matter. The benefit for the board is that their decision seems far more rational and dispassionate than it truly is. Well, it’s not.

If I had my way, the board would be in complete control of executive pay and they would decide by fiat each year. No formulas or stock options. Simply, here’s how well we think you did, and that’s that. For untested companies I see the drawbacks, but for successful ones, I think it’s better for everyone, especially shareholders.

Which brings me to another point. While I’m not so bothered by executive pay, I am bothered by the lack of independence of corporate boards. Their job is to represent shareholders, and far too many are lackeys for kingpin CEOs. It’s taken me a long time to reach this point but I don’t believe any CEO should be on the board of directors. None. Just cut the two entities entirely. CEOs should not be media celebrities.

Jamie Dimon at JPMorgan Chase is a perfect example, and I say this as someone who has JPM on their Buy List. Mr. Dimon should be CEO or on the board, but not both. My preference is to see him leave the CEO suite.

Posted by on May 8th, 2013 at 3:00 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.